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Make Your Retirement Income Go Farther With this Tax-Efficient Withdrawal Strategy


Workers spend decades saving for retirement, building a nest egg they hope will sustain them when the time comes to retire. But saving your money is just one part of the puzzle that is retirement planning.

A financial advisor can help you plan for retirement and create a strategy for withdrawing your savings. Find a fiduciary advisor today.

How you withdraw your money in retirement can significantly impact your tax bill from year to year, as well as the overall lifespan of your retirement nest egg. Analysis from T. Rowe Price shows how taking withdrawals from tax-deferred accounts first and using the standard deduction to offset income taxes owed on the money can save a retiree thousands of dollars and extend the life of their savings.

Rethinking the Conventional Approach to Retirement Income

Some retirees may benefit from rethinking the conventional approach to withdrawing retirement funds, according to T. Rowe Price.

The conventional approach for generating retirement income (beyond Social Security payments) is to withdraw money from taxable accounts first, followed by tax-deferred accounts, like traditional IRAs and 401(k)s, and Roth accounts last. By adhering to this traditional strategy, a retiree leaves his tax-advantaged assets in their respective accounts for longer, where they can continue to grow on a tax-deferred or tax-free basis until they are truly needed.

But this approach may result in an unnecessarily inflated tax bill, which can reduce the lifespan of a person’s retirement portfolio, according to T. Rowe Price.

As an example, researchers at T. Rowe Price considered a married couple with $750,000 in assets spread across several different accounts. The couple has 60% of their money in tax-deferred accounts, 30% in Roth accounts and 10% in a taxable brokerage account. In retirement, the couple spends $65,000 per year after taxes and collects $29,000 in Social Security. As a result, the couple must withdraw approximately $36,000 per year to meet their spending needs.

By adhering to the conventional withdrawal approach, the couple first taps their taxable brokerage account. They won’t have to pay any long-term capital gains taxes on the withdrawals because their combined income is below $83,350. However, these taxable assets will be depleted quickly and fully exhausted early in their third year of retirement.

The couple then turns to their tax-deferred traditional IRA assets, which are withdrawn each year and last into the couple’s 18th year of retirement. From that point on, Roth IRA assets serve as the primary way the couple supplements their Social Security income. Since the taxes have already been paid on this money, withdrawals are made tax free.

However, this approach results in some $35,000 in federal income tax being paid in years 3 through 17, when the couple’s withdrawals from traditional IRAs are taxed as ordinary income. As a result, their portfolio is exhausted during the 30th year of retirement, signaling a need for a more tax-optimized withdrawal strategy.

A Better Approach to Retirement Income?

A retiree adds up his expenses and income. T. Rowe Price says some retirees should rethink the conventional approach to withdrawing retirement funds.

There’s a better way to draw down assets and limit taxes owed in retirement, according to T. Rowe Price. This tax-optimized approach, which shuffles the order in which money is withdrawn from various accounts, relies on the tax-deferred IRA accounts first, followed by taxable and Roth accounts.

By taking the standard deduction, the couple’s first $25,900 in income in 2022 isn’t subject to taxes. While money withdrawn from a tax-deferred account is typically taxed as ordinary income, the couple uses the standard deduction to offset this income and avoid paying federal income taxes on it.

The couple then withdraws approximately $10,000 from their taxable and/or Roth accounts to meet the rest of their spending needs. While doing so means tapping Roth assets in the seventh year of retirement, it also extends the life of the couple’s taxable account, which also lasts seven years into retirement.

More importantly, this strategy saves the couple $35,000 in federal income taxes and adds about two years of longevity to the couple’s portfolio, T. Rowe Price found.

Bottom Line

How you withdraw money in retirement is an important consideration. The conventional approach to retirement withdrawals relies on a retiree’s taxable account first, followed by tax-deferred assets, and finally, Roth assets. However, the standard deduction allows you to offset the heftier income taxes you’d otherwise owe on withdrawals from tax-deferred accounts. Using those assets first, followed by withdrawals from taxable and Roth accounts, can limit federal income taxes and lengthen a retirement portfolio’s lifespan, T. Rowe Price found.

Tips for Retirement Planning

  • A financial advisor can help you save for retirement and make a plan for withdrawing your savings in a tax-efficient manner. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Required minimum distributions (RMDs) are an important component of retirement planning. Understanding how they work and how to calculate your RMDs is vital to a successful retirement plan.
  • It’s never too early to start thinking about your plan for retirement. SmartAsset’s retirement calculator can help you estimate how much your savings will be worth when it comes time to retire. The free tool can also illustrate how increasing your savings rate today can help you in the future.

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